Fall in inflation and prospects of rate cut

Briefing the Public Accounts Committee (PAC) on 2nd March, 2020, the Governor State Bank of Pakistan, Dr Reza Baqir stated very clearly that the SBP was considering cutting down policy rate following a decline in inflation. The interest rate would reciprocate to the declining inflation that would go down in the coming days. "We are trying to build confidence of investors in our system both locally and globally. Real interest rate at present is not too high," he argued. Responding to questions regarding saving the interests of the savers and borrowers, the Governor stated that increase in savings and investment was the need of the hour but investors did not borrow massively despite very low interest rates in the past. Giving reasons for the recent inflation, he said that increase in the rate of inflation was the result of disruption in supply chain and depreciation of the rupee against the US dollar. As per SBP estimates, inflation rate is likely to remain in the range of 11.0-12.5 percent during the current financial year.

Responding to other questions of the members of PAC, the Governor stated that growth in the large-scale manufacturing sector had resumed and inflation was likely to decrease in the coming months. The IMF is facilitating Pakistan in economic reforms and foreign exchange reserves of the country are improving that will help stabilise the economy as well as the market. An amount of dollar 3.0 billion has been invested in Pakistan as "hot money" from the US, UK and UAE and this is not a new phenomenon. Similar investments were made in the past in the country to maximise interest or capital gains. Pakistan is also getting more export orders due to coronavirus in China and supply of commodities is also affected from China due to the same reason.

The briefing of the Governor on the economy to the PAC members, particularly on the relationship between inflation and the policy rate and some other important areas of the economy was, in our view, quite straightforward and in accordance with the economic reality now prevailing in the country. As all students of even elementary economics know, the policy rate of a country is very closely related to the rate of inflation. Higher the inflation rate in the country, higher will be the policy rate of the central bank and vice versa, and this tool of monetary control is also used to counter inflationary expectations and encourage or discourage the inflows or outflows of hot money. Since the appointment of Dr Baqir as Governor of the central bank of Pakistan, he has been severely criticised for jacking up the discount rate to a very high level but this was not his mistake. He was only doing his duty to help stabilise the economy. Had he not done this, price stability would not have been achieved and foreign exchange reserves held with the SBP would not have been at a comfortable level of over dollar 12.5 billion. It could, however, be argued that the Governor should not have talked about the cut in policy rate on the basis of only one month's data on inflation, i.e., for February, 2020, and refrained from speaking about the cut in the policy rate so openly because his remarks could make a hell of difference in the money market beforehand. Central bank Governors usually avoid such talks before decisions on monetary policy or discount rates are actually made. Moreover, the Governor is unaware of the government decisions which could adversely affect the inflation rate in the coming months. For instance, the government has not passed on the impact of fall in international prices of oil to the domestic market fully and has increased the wheat support prices for the fresh harvest commencing in Sindh from this month and in Punjab from next month. Both these decisions are inflationary and could constrain the SBP to have a fresh look at its policy.

Anyhow, the statement of the Governor to cut the policy rate is likely to give a great relief to the business community and other borrowers of banks who have been agitating against high policy rate vigorously and persistently. The decision is also likely to reduce the debt servicing of the government and expand private sector credit which would serve to accelerate economic activity, and increase employment level in the country.